The U.S. Makes Its Comeback w/ Andreas Steno Larsen

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0:55The signals are telling me that the US economy is re-accelerating. Welcome to this edition of Steno Signals. My name is Sandria Steno, and I'm glad to be back here at the platform week in and week out with my macro views and also ultimately a discussion on how to trade these macro views. This theme of a reacceleration of the US economy is one that has been basically been discussed over the course of the autumn at Real Vision. And I think Raul Powell has been on top of this re-acceleration in the liquidity and macro cycle that we've seen lately. So I'll spend some time today on elaborating why we see this re-acceleration of the economic cycle and whether it will wreak havoc with the views of the U.S.

1:45Federal Reserve. Are they expecting growth to decelerate here? And will this re-acceleration of the cycle wreak havoc with their plans to cut interest rates? I guess that's one of the key questions for 2024 now. But if we look at the gross domestic product of the United States, we've had two consecutive quarters of substantial positive surprises. Both the third and the fourth quarter basically delivered extreme growth, in my humble opinion, relative to expectations. And it seems like the economy is actually accelerating even from that outset into 2024. If we look at a couple of indicators of why that is, first of all, we have an explosion, basically in outright terms, in the exports of semis from Korea to the US.

2:39If we look at the shipments of semis from South Korea, one of the large suppliers of semis globally, we see a large increase year and year. That's what you see in the dark blue line here. And typically, that is a strong but early signal that the manufacturing cycle is actually improving in the US economy. Why do we see such cyclicality in semis? Well, semiconductors are cyclical as a consequence of the whole semiconductor space being cyclical of nature. And when there is an increase in demand for semis, it's typically a sign that the overall economy is improving from a cyclical perspective. When we look at semis right now, it's obviously at least partially related to the boom within AI.

3:25But even if AI is booming, we should still expect semis to act cyclical from a macro perspective. So when we see a pickup in the activity of semis, it's both a strong signal that the AI wave is still ongoing, but it's also a signal that the US economy is gaining pace rather than the opposite. If we look at what the manufacturing companies, what they're telling us right now, if we look at their order books relative to the size of their inventories, we now see an improving ratio between the two again. And orders books have been pretty depressed through the autumn, but we now see the early signs of the pickup in the size of orders relative to what they already have at inventory.

4:12I think that's a strong signal of upcoming activity. This ratio is a very strong gauge of activity, say, three, four, five months ahead. And we now see convincing signals that we're past the bottom in the manufacturing sector. And, well, needless to say, the manufacturing sector has struggled for most parts of 2023, but we're now past the worst part here. And that is the ultimate signal that the U.S. economy is actually gaining pace from a cyclical perspective. Over the course of the past week, we also received the so-called SLUES survey conducted by the Federal Reserve. They ask banks and credit institutions once a quarter around the standards for credit and also around the demand side in the credit equation.

5:07And this chart is basically a measure of the demand for loans in the economy in dark blue relative to a live measure of financial conditions in the US economy in light blue. And what we've seen essentially since Powell pivoted in Q4 of 23 is a material easing of financial conditions in the US economy. typically what we see with a time lag is an increase in the demand for loans, even demand for loans within the commercial real estate sector, for example, as a consequence of these easier terms. And we now see that materializing in the SLU survey. We see less tight standards for credit. We see a slight pickup in the demand for loans.

5:58So again, here from a sequential perspective, we're now moving in the right direction. And that is very interesting, given that most people probably anticipated that first quarter here would still be weak in the US economy. And some people even discussed whether we would have a recession in 24 through the latter parts of last year. But having said that, I mean, it's crystal clear that the economy is actually improving here. Are the numbers that we've seen so far in January actually a fair reflection of what's ongoing in the US economy. My take would be no. We obviously had a very strong job report last week.

6:39We had a very strong survey from the service sector, from the Institute of Supply Management. But I'd like to show you one chart showing sort of the seasonal patterns and the way that the statistical bureaus of the United States conduct seasonal adjustments. So this bar chart shows whether a month is artificially helped by seasonal adjustments. In such case, we will have a positive bar or vice versa with a negative bar. And January typically receives a bit more help than it should in these seasonal adjustments, especially in the non-farm payrolls. So these numbers seen in January, they are indeed positive, but they are not as positive as they look on the surface.

7:32And as you can see here, we have a pretty clear divergence between the first half of the year and the second half of the year in this chart. So the first half of the year typically sees positivity due to seasonal patterns, while we see the opposite in the second half of the year. This is, among other things, a result of the so-called COLA adjustments in the U.S. economy, mechanical adjustments to both tax brackets, social security benefits, and all that. They're adjusted by the cost of living index from the year prior, meaning that first of Jan households simply get an improvement of their spending power situation as a consequence of these benefits and these tax brackets being hiked by the cost of living from the year prior.

8:17If we look at new orders, to take an example from the ISM index on the next chart, as you can see, the dark blue line here is an example of a seasonal adjustment factor that is out of sync with what we've typically seen in the ISM surveys. So when the seasonal adjustment factor is low in this chart, it means that spreadsheets aid the final number higher in the ISM survey. So be aware of that. The numbers looked prettier than they actually were here in January. And it particularly holds for the non-farm payrolls report. If you look at the non-farm revisions on the next page, I've conducted a very simple study on the seasonal adjustment factors of the non-farm payroll number.

9:11And the light blue bar is the number that was reported. If we turn off the outlier filter in the so-called X13 ARIMA seeds methodology to adjust for seasonality, used by both the Bureau of Labor Statistics, used by the Institute of Supply Management and all of those, we get a number that is 100K lower. if you adjust for the lack of seasonal layoffs post the pandemic, you get to a number that is even lower for January. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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11:37My point here is, if we look at the next page, the actual payroll number in January, if you set aside seasonal adjustments, was at roughly minus 2.6 million jobs. That's not out of the ordinary. That's what we typically see in January due to seasonal layoffs after the Christmas season. The problem is that the layoffs are a tad smaller than they typically are, or rather they're a tad smaller than what they've typically been before the pandemic, while the seasonal adjustments even increase the numbers on top of that. But the point is here that the January job report was not as strong as reported.

12:20And what we've seen lately is obviously a repricing of both the growth outlook, but also the interest rate outlook from the Federal Reserve as a consequence of all of these strong numbers. So what could drive developments in interest rates into the spring, given these seasonal patterns that I've just described? Well, tomorrow on Friday, we get the annual revisions to both the seasonality factors in the inflation index, but also to the weights for each and every cost category in the inflation index. And I'd like to highlight the developments in consumption patterns in 2022. The Bureau of Labor Statistics will use 2022 to recalibrate the inflation index for 2024.

13:09And what you see on the chart here is that food consumption dropped in volume terms, while we had an increase in the expenditures within services, also relative to goods. So this essentially means that housing will be more relevant in the inflation index when they update it. It means that services will be more important than goods on a relative basis compared to 2023. So is that a positive or a negative? Well, if we look at it from an inflation perspective first, when housing increases slightly in significance in the inflation index, it basically means that the probability of inflation veining further from here is good, or that the probability is high rather.

13:58because of lags in the way that housing costs are measured in the inflation index. We typically see in between 12 and 18 months of lag between actual new leases and the ultimate timing of the disinflation seen in new leases in the inflation index published by the Bureau of Labor Statistics. So I actually think this is net-net something that speaks in favor of rate cuts through the spring. If we look at the actual numbers, I have a table on the actual spending changes in 2022. Healthcare, energy, and clothing and footwear will be sort of reweighted up in the inflation index, while used cars, food, transportation services will be reweighted down.

14:48Net-net, I think this is dovish and we'll get the final numbers delivered by the Bureau of Labor Statistics tomorrow. So keep an eye out for those. Essentially, what I'm trying to say here is that I think interest rates will have to drop, both as a consequence of January numbers being a bit too elevated due to seasonal patterns and also due to these adjustments to the inflation index. So let's try to become as concrete as we can. The liquidity outlook and the outlook for interest rates, both of those outlooks obviously matter for risk allocations and for trading. And when we look at the liquidity outlook first, it looks very benign for the US economy over the course of Q1 and early Q2.

15:34The reason is that the so-called reverse repo facility at the Federal Reserve is being depleted right now. Money market funds pull out money from the Fed. They invest in bills, meaning that deposits in the real world are created during the process. The Federal Reserve has told us as soon as this overnight reverse repo facility is close to zero, they'll end the quantitative tightening program. To me, that means that the March meeting is very live in terms of taking that decision. So maybe we do not get a rate cut in March, but we'll get a tapering decision to the QT program, which is pretty bullish for risk assets.

16:16So a benign liquidity scenario with interest rates cuts upcoming through the spring, it sounds like a pretty decent cocktail, and it is when we look at it empirically. When we look at liquidity versus the S &P 500, first of all, we have an almost picture-perfect correlation between the yearly changes of the two. And as I told you, we should expect liquidity to increase, say 10 to 20 % on the year through the spring here, meaning that there is a pretty decent probability of new highs in the S &P 500, in particular in stocks with a high sensitivity to this liquidity story. And I've made a heat map of such indices with a high sort of liquidity sensitivity.

17:02And at the very top of the leaderboard, you have the NASDAQ index. So basically technology. I'm heavily invested in that, narrative myself. I know Raoul is as well, and it basically rhymes with what we see in the economic cycle and in the liquidity cycle right now. If we look at how interest rates typically behave, given the increase in liquidity, I think it's relatively safe to say that the yield curve will steepen in such a scenario. So on the next page, we have a chart showing the yearly change in liquidity, dark blue, versus the spread between five-year and two-year interest rates in the dollar curve.

17:46So essentially, when we see a liquidity increase, it's typically a sign that interest rates will be cut. But it is also a sign for sort of longer-term interest rates, in this case, five-year interest rates, to move up relative to the front end. And therefore, the curve steepener in the dollar curve looks very attractive here as a consequence as well. So all of this in relation to the Fed outlook, I mean, we've basically talked about how they can take a decision on QT already by March as a consequence of these liquidity trends and as a consequence of the overnight reverse repo facility. But what about inflation?

18:29I mean, now that the cycle is improving again at a time where inflation is not back at target levels. Is that an issue from an inflation perspective? In the last special edition of StenoSignals, we talked about how the distortions to global supply chains could lead to a revival of inflation due to higher shipping costs, both due to issues in the Red Sea and the Suez Canal, but also due to issues in the Panama Canal. But let's have a brief update on the actual developments in shipping space. If we look at freight rates over the past couple of weeks, we've actually seen a fading trend in the shipping routes between China and Europe.

19:13And those have been sort of center of attention due to the issues in the Red Sea. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

19:29But we still see increases in the shipping rates between, say, Shanghai and LA, for example, so between China and the US. So there's a discrepancy here. And why is that? Well, if we listen to Maersk, also the biggest Danish shipping company, they posted their annual report earlier. and they basically said that they saw better demand side in the US relative to Europe. And that's one of the reasons why we see this divergence in trends in freight rates now with shipping rates towards the US still picking up relative to Eurozone equivalents. And I think that's a strong hint that the US economy is performing better than peers.

20:17But we're still stuck in a situation with very few ships in the Red Sea and very few ships in the Panama Canal. This fresh example here is an example of the amount of activity in the Red Sea relative to usual levels. So 100 % is sort of a typical level. And we're, as you can see, far below that, 60 % down or so, meaning that the Houthis, this group from Yemen, they've still managed to sort of wreak havoc with supply chains through the Red Sea. And we know that the Panama Canal is still not functioning at full capacity either. So we have shipping distortions despite this slight veining trend in freight rates.

21:03But we're currently helped a lot by seasonality in terms of global shipping. That's the final chart I want to show you today. If we look at typical patterns of when goods are shipped from China to the US, we're basically at local lows or yearly lows here in February. This is the month with the sort of least activity in shipping space from China to the US. As you can see, as soon as we approach March and April, we get a sort of a cyclical pickup from seasonal patterns. in the actual shipping activity. And if we get to March, April without any improvement in the situation in the Red Sea or in the Panama Canal, currently that would be my base case that we don't get that improvement before March, April.

21:56We should probably expect prices on various shipping routes to increase again. And ultimately, I think this is currently the biggest risk to the whole cutting cycle narrative. that we get increasing freight rates, increasing price patterns in goods imported by a sea, and an ultimate spillover to consumer price inflation as a consequence. So ultimately, how do we trade all of this? This is a snippet from our current portfolio. We're long tips, so rising inflation relative to interest rates. We're short euro dollar, basically on a bet on a relatively stronger demand development in the US. And as you can see, we're long XLK, the technology bet.

22:46We're also long the curve steeple, STU, and a couple of other trades. So it all rhymes with this improving cycle, but we still need to be aware of the risk of an acceleration in the price of goods as a consequence of this re-acceleration of the economic cycle in the US. And that is one of the things that I'll keep on tracking over the course of the early spring in this show. With those words, I'd like to say thank you for watching StenoSignals. And I'll be back again next week with another macro update. Remember that this is a window into my thinking on macro and how to trade it. I cannot guarantee that you have the same risk appetite or risk horizon as I have.

23:30But what I can guarantee you is that I'll be back week in and week out with the show StenoSignals here at Real Vision. Thank you for watching.

23:56our free offer at realvision.com forward slash free.

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